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Six Economic Signposts for the Road Ahead

Monday, January 6, 2014 6:50 AM

Remember not so long ago when a paper roadmap was the primary tool for navigating to an unfamiliar destination? Today, a seemingly unending variety of global positioning systems makes the job easier. Even with the latest navigational technology, however, road signs along a route still provide a measure of confidence that travelers will arrive at their destination successfully.

It’s much the same when trying to project what the economy and credit union performance will look like a full year from now. While no one can see the final destination, road signs along the way may provide guidance for the journey.

Here are six road signs that Brian Turner, chief strategist at Catalyst Strategic Solutions, says we should look for in 2014:

The pace of economic growth will increase next year, but consumer spending will remain volatile.

The employment sector remains the primary driver of the economy. Growth has suffered from consumers’ job insecurity and tepid spending behavior. So far, the 2.6 percentage point decline in the nation’s unemployment has produced half of the economic recovery traditionally experienced during comparable drops in unemployment in the past.

The pace of decline in the unemployment rate will begin to slow in 2014, ending the year around 6.8 percent. Personal spending is expected to increase at a 2.7 percent annualized pace next year, better than the 2.0 percent increase in 2013. As a result, after hitting a three-year low in 2013, the pace of economic growth is expected to increase from this year’s 1.7 percent pace to 2.5 percent in 2014.

Economic growth will not be strong enough to produce robust loan or share growth.

Inflation will be a non-issue in 2014, although wavering energy and food prices may have an impact on consumers’ disposable income. Retail sales are expected to increase next year, but the pace of vehicle and home sales is expected to decline. Despite stagnant wage growth, the pace in share growth will increase next year, following historical trends with disposable income.

The industry’s challenge with loan growth also will continue next year. The market remains insensitive to rates, and spending depends entirely on individual sentiment on their prevailing household wealth and perceived stability of their current disposable income. The Mortgage Bankers Association is expecting mortgage applications to decline 33 percent next year, with the refinancing share of originations to drop below 40 percent. This suggests that, in order to experience a material increase in overall loans next year, credit unions will require greater growth in consumer loans. This could prove difficult in light of the projected growth in spending next year.

Short-term interest rates will remain low, but volatility in longer-term rates will continue.

The Federal Reserve has stipulated that it will consider raising its overnight target rate only after the nation’s unemployment rate drops below 6.5 percent and inflation is no higher than 2.5 percent. They appear to be targeting the summer of 2014, but underlying data suggests that these triggers will not be attainable until sometime in 2015.

So, we can expect little movement in short-term interest rates through the end of 2014, although they may climb a few basis points higher. Longer-term rates will continue to bear the burden, as the Federal Reserve attempts to keep rates down, and market forces try to push rates higher. This could result in a flatter yield curve at the end of the year, with rising consumer loan rates and declining mortgage rates.

Most credit unions will not experience comparable industry results.

The industry has seen historical performance disparity over the past few years. As a whole, the industry is experiencing a 5.5 percent increase in loans. However, larger credit unions ($500 million or more in assets), which account for 67 percent of the industry’s assets but only 7 percent of the total number of credit unions, have experienced a 9.2 percent increase in loans. This implies that the remaining 93 percent of credit unions collectively have experienced a 2.4 percent decline in loans.

Share growth has shown a similar pattern, as the overall industry has experienced a 7.2 percent increase. But shares at the larger credit unions have increased 10.5 percent while, collectively, the “93 percenters” have realized only a 0.9 percent increase in shares.

This disparity most likely will continue in 2014. The best way to forecast at the credit union level would be to expect only a slight increase over 2013 loan growth, but greater improvement in share growth. Larger credit unions should be able to repeat 2013’s strong growth rates next year.

Opportunities to improve earnings will still exist in 2014.

In the meantime, net asset yields have stabilized, as declining delinquency continues to support slightly higher nominal asset rates. Mortgage rates are a full percentage point higher than last year, but many credit unions are still reluctant to retain mortgage loans on their balance sheet – a primary factor at underperforming credit unions over the past couple of years. Mortgage lending opportunities will continue in 2014, even if mortgage rates end the year lower. The volume of applications, however, most likely will decline. One thing is clear: consumer loans must increase to enable credit unions to experience any growth results in 2014.

Although there is still some room to lower cost of funds, the floor is much closer. Credit unions should retain a short-term funding duration. Long-term certificates offer little benefit to long-term cost of funds and provide little protection against rising rates, because of inadequate early withdrawal penalties. This will be easy to manage as the growth of non-term shares is expected to outpace term certificates.

2014 will be another transition year, but greater demand and wider spreads are right around the corner.

The greatest challenge next year will be to remain patient. Growth will be stronger in a couple of years, member demand will improve, and net margins will begin to widen (yes, even with rising interest rates). Try to be more proactive in lending next year, without compromising underwriting standards. Retain a short-term funding duration (it won’t compromise long-term cost of funds), and remain frugal with operating expenses to help offset expected lower fee revenues.